THE ECONSTORM IS COMING.

TIME HAS COME TO SEE THE VIRTUAL ELEPHANT IN THE LIVING ROOM.

Derivatives instruments are the most perplexing financial instruments. The very definition of derivative is ‘those financial instruments whose values are derived from the value of something else generally called the underlying if X is the prevalent condition’. It states that the value of the instrument depends on the underlying values and the environment conditions and this in turn depends upon X, Y, Z… factors. Derivatives depends upon very many unknowns so it would not be wrong for me to term it as a very vague instrument and an instrument people are not very familiar with, as at any stage the holder of this instrument does not know its real value. He is always in the dark because the value is determined by very many unknowns that have not yet taken a shape.

The current financial situation is dismal to say the least. There are bank runs, bailouts, foreclosures, bankruptcies, tent cities, ponzies, market indices in a downward spiral etc. With all these jargons making rounds in the financial spheres I was rather amazed that derivatives have not been spoken about in great depth. So I decided to give it a try. The findings if are true are very depressing.

Derivative contracts total about three-quarters of a quadrillion dollars in “national” amounts, according to the Bank for International Settlements. These contracts are tallied in notional values because no one really can say how much they are worth.

But valuing them correctly is exactly what we should be doing because these comprise the viral disease that has infected the financial markets and the economies of the world.

Try as we might to salvage the residential real estate market, it’s at best worth $23 trillion in the US. We’re struggling to save the stock market, but that’s valued at less than $15 trillion. And we hope to keep the entire US economy from collapsing, yet GDP stands at $14.2 trillion.

Compare any of these to the derivatives market and you can easily see that we are just closing the windows as a Tsunami crashes to shore. The total value of all the stock markets in the world amounts to less than $50 trillion, according to the World Federation of Exchanges,

To be sure, the derivatives market is international. But much of the trouble we're in began with contracts "derived" from the values associated with U.S. residential real estate market. These contracts were engineered based on the various assumptions tied to those values.

Few know what derivatives are worth. Derivatives pricing, simply put, is determined by what someone else is willing to pay for the contract. The value is based on an artificial scenario that "X" will be worth "Y" if "Z" happens. Strip away the fantasy, however, and the reality of the situation is akin to a game of musical chairs -- without any chairs.

So now the music has finally stopped.

That's why stabilizing the housing market will do little to take the sting out of the snapback we are going through on Wall Street. Once people's mortgages were sold off to secondary buyers, and then all sorts of crazy types of derivative securities were devised based on those, and those securities were in turn traded on down the line, there is now little if any relevance to the real estate values on which they were pegged.

We need to identify and determine the real value of derivatives before we give banks and institutions a pass-go with more tax dollars. Otherwise, homeowners will suffer as banks patch up the holes left in their balance sheets by the derivatives gone poof; new credit won't be extended until the raff of the old credit is put behind.

It isn't the housing market devaluation, or the sub-prime mortgage market defaults that have us in real trouble. Those are nice fakes to sway attention away from the place where greed truly flourished -- trading phony instruments to the tune of $700 trillion.

Let's figure how to get out from under that. Then maybe the capital will begin to flow again through the markets. Right now, this elephant isn't just in the room, it's sitting on us.